Inflation Peaked. Next Up: Stagflation or Recession?
Signal Definer: Blocked. Equities saw their worst performance since early-pandemic, and bond prices were the victim of higher rates.
April Market Recap
The S&P 500 Index returned -8.80%
The Bloomberg U.S. Aggregate Bond Index returned -3.79%
Fed Funds Target Range: 0.75 – 1.00%
Economic Review
The International Monetary Fund (IMF) released projections of the impact of the war in Ukraine. Global growth will likely slow from an estimated 6.1% in 2021 to 3.6% in 2022 and 2023. This is 0.8 and 0.2 percentage points lower for 2022 and 2023 than projected in January.
The war isn’t just impacting growth. The IMF also reported that war-induced commodity price increases and broadening price pressures have led to 2022 inflation projections of 5.7% in advanced economies and 8.7% in emerging market and developing economies—1.8 and 2.8 percentage points higher than projected last January.
U.S. inflation hit 8.5% in March, a 41-year high. The March unemployment number came in very strong and the unemployment rate fell to 3.6%, just slightly above pre-pandemic levels. In remarks at a panel discussion at the IMF on April 21st, Fed Chairman Powell reiterated that it is appropriate “to be moving a little more quickly” on rate hikes. That translated into guidance on the first 50-bps rate increase in 22 years.
Economists began talking about “stagflation.” Stagflation is high inflation, high unemployment, and slow or negative real economic growth. Stagflation fears rise out of the potential for the Fed to overshoot and tip the economy into recession. Another way to think of stagflation is a circular firing squad. In stagflation, the moves the central bank makes to rescue the economy push it further into recession.
The “Soft-Landing” May Be A Hard Sell
The April numbers on unemployment and inflation would seem to be slightly headed in the right direction. The Bureau of Labor Statistics (BLS) reported that the inflation as measured by the consumer price index (CPI) slowed in April, with an annual inflation rate of 8.3%, which marked a decline from 8.5% in March. The producer price index (PPI) also slowed, down to an 11% increase from a year ago, versus an 11.5% increase in March.
The economy added 428,000 jobs in April, and the unemployment rate was unchanged at 3.6%. The household survey found some softening in labor markets, as the labor force participation was 62.2%, the lowest in the last three months.
However, there was a new wrinkle: GDP turned negative in the first quarter, down 1.4% as reported by the Bureau of Economic Analysis. Two consecutive quarters of negative growth usually indicates a recession.
Chairman Powell’s remarks on May 12 were not exactly reassuring. Powell defined a soft landing as “getting back to 2% inflation while keeping the labor market strong.” He admitted that “it will be challenging,” and also stated that wages are moving up at levels that are unsustainably high and not consistent with low inflation.”
Market Review
The S&P 500 became more volatile, trading in a high/low range of 11.38%, compared with the pre-COVID-19 historical monthly average of 6.86%. The index ended the month with its worst one-day return (-3.63%) since June 11, 2020, and is in correction territory. Intra-day volatility is up, trading volume is down, and breadth not only declined, but it also turned negative as only 105 issues gained, compared with March’s 315 gainers.
The 10-year U.S. Treasury ended the month at 2.93%, and the 30-year U.S. Treasury ended at 3.00%, up from last month’s 2.45%. The Bloomberg U.S. Aggregate Index was down, returning -3.79. As represented by the Bloomberg Municipal Bond Index, Municipal bonds returned -2.76%. High yield corporate bonds struggled with rising rates, with a return of -3.55% for the Bloomberg U.S. High Yield Index.
The S&P LSTA Leveraged Loan Index saw performance of BB-rated loans on top of the leaderboard for a second consecutive month with a return of 0.42%. Single-Bs were slightly behind the broad Index at 0.19% for the period, while CCCs lagged notably, at -0.50%, and have been in the negative territory for every month since January.
The full year 2021 performance of the Cliffwater Direct Lending Index, an asset-weighted index of over 8,000 directly originated middle market loans totaling $191 billion as of December 31, 2021, was 12.78%. Fitch Ratings reports that companies in business services, technology and healthcare have served as a large source of issuance in direct lending. Relative to issuers in other sectors, exposure to increased labor and raw material costs might be low for these companies.
